Chapter 10: Commercial Property Insurance Flashcards
mercantile risks
Different types of business operations, and their different types of exposure,
Considerations for Commercial
1) Building.
2) Stock.
3) Equipment.
Building
- Fixed structures pertaining to the building and located on the premises.”
“Premises” are defined as the entire area within the property lines and areas under adjoining sidewalks and driveways. It includes erected pole signs, yard lights, and perimeter fencing constructed on the premises. Each structure must be noted on the declarations to be covered by the policy.
“2. Additions and extensions communicating and in contact with the building.
- Permanent fittings and fixtures attached to and forming part of the building(s).”
The value of plumbing, heating, air conditioning, lighting fixtures, wall-to-wall carpeting, and other permanently installed equipment is included in this amount.
“4. Materials, equipment and supplies on the premises for the maintenance of, and the normal repairs and minor alterations of the building or for building services.”
Any material on site for new construction or major renovation would not be covered.
“5. Growing trees, plants, shrubs or flowers inside the building use for decorative purposes when the insured is the owner of the building.”
This applies to the owner of the building, because a tenant would not have an insurable interest in the building.
Stock”
“1. Merchandise of every description usual to the insured’s business.”
The type of business in which the insured is engaged will usually be indicated on the declarations page. When a client purchases stock insurance, they receive coverage for all merchandise or items sold that are usual to that business. For example, If the insured’s business was described as a bookstore, but they submit a claim for bicycles sold by the shop, the insurer would have grounds to deny such a claim.
The rate and premium charged are based largely on the nature of the stock, because there is a wide variation in susceptibility to loss from one type of stock to another. For example, high-end bicycles have a higher potential for loss and would warrant a higher premium.
“2. Packing, wrapping and advertising materials.”
This includes all material used to distribute any of the merchandise sold. It includes advertising and promotional material, such as flyers and catalogues.
“3. Similar property belonging to others which the insured is under obligation to keep insured or for which the insured is obligated.”
Note that, under this definition, the property lost or damaged must be similar to that insured by the policy. This means that goods held on consignment must be similar to those stated on the declarations page.
The insured must have had an obligation to keep the property insured. The normal practice is to have a written agreement in place outlining the obligations of both parties.
Additionally, the insured must have been legally obligated either as a bailee or based on the standard of ordinary care. From an underwriting point of view, it is important to know the nature of all the stock in a building and how it relates to the insured’s business.
Equipment
“Equipment” is defined as:
“1. Generally all contents usual to the Insured’s business, including furniture, furnishings, fittings, fixtures, machinery, tools, utensils and appliances other than ‘building and stock’.”
Equipment can include office furniture, fittings, and display cases, as well as machinery ranging from air compressors to forklifts.
“2. Similar property belonging to others which the insured is under obligation to keep insured or for which they are legally liable.”
You might remember this clause from the definition of “stock,” and the intention is identical. Many operations lease or rent equipment, such as photocopiers, computers, office furniture, and forklifts, so this definition includes those items. Brokers need to know not only what is owned, but also any lease agreements related to the business.
“3. Tenants improvements, which are defined as building improvements, alterations and betterments made at the expense of the Insured to a ‘building’ occupied by the insured and which are not otherwise insured provided the Insured is not the owner of the building.”
Renting space in multi-use buildings — such as malls or high-rise buildings — is very cost-effective for many insureds. The space is often unfinished and the tenant/insured finishes the space to their own specifications. These tenant improvements and betterments are normally left in the building when they leave. Because the tenant has no interest in the building, but they paid for these improvements and betterments, these tenant improvements must be insured as equipment on the tenant’s policy.
If the insured purchases the use interest on tenant improvements made by the previous tenant, this form applies as though the tenant improvements had been made at the expense of the insured.
Once the broker has identified these components and given the appropriate values by the insured, the broker can then analyze the risk exposure each component presents. However, there may be challenges to ensuring adequate limits are met. To ensure adequacy of limit we apply the co-insurance clause with a co-insurance factor dependent on the type of building, operation and products (discussed in Section 10.3.5). Once all these parts are determined, we can then look at the type of policy required to meet the insured’s requirements and expectations.
Determining Insurance Values
(ACV) and replacement cost (RC). The traditional meaning of ACV is the cost to repair or replace lost or damaged property, less the application of any depreciation. In other words, it’s today’s price, less depreciation. RC represents the costs to repair, replace, or rebuild the lost or damaged property, without deduction for depreciation. Insuring a building on an RC basis usually requires a proper appraisal.
Stock is insured on ACV basis, whereas equipment can be insured on either. Again, the onus is on the insured to provide the proper data to ensure adequate limits in case of loss. These limits can be determined from invoices and inventory figures, and they are probably easier to determine than building values. (This is particularly true for older buildings, whose valuations can be more subjective.)
Co-insurance Clause
DID / SHOULD * LOSS = PAYOUT
Essentially buying insurance less than the amount that would cover your property and willing to incur a loss for a smaller premium
Below is an example of a co-insurance clause:
“This clause applies separately to each item for which a co-insurance percentage is specified on the Declarations page and only where the total loss exceeds the lesser of 2% of the applicable amount of insurance or $5000.
The insured shall maintain insurance concurrent with this form on the property insured to the extent of at least the co-insurance percentage specified on the Declarations page of the Actual Cash Value (ACV) thereof and failing to do so, shall only be entitled to recover that portion of loss that the amount of insurance in force at the time of loss bears to the amount of insurance required to be maintained by this clause.”
In commercial property, the insurer will normally require the insured to purchase an amount of insurance which, as a minimum, is equivalent to a predetermined percentage of the property’s value (usually 80% or 90%). When the amount of insurance purchased is less than this amount, the insured will be required to share in any future loss (that is, pay themselves). The formula used to determine the amount of the loss to be borne by the insured is included in the policy’s co-insurance clause.
The co-insurance clause exists because many people will deliberately under-insure to reduce the amount of premium they pay. Others may be careless in their estimate of current values and end up woefully under-insured. In other cases, they are expecting to suffer only a partial loss, so they base their purchasing decisions on that expectation. However, in the event of a total loss, insureds often expect full payment for partial losses — even if they failed to pay sufficient premium to cover the whole property.
The co-insurance clause prevents this from happening. In the event of a total loss, the payout to the insured is limited by the policy limit purchased. This means that, if the insured is under-insured, they would suffer a financial loss to the amount they are under-insured for. In the event of a partial loss, they would also be penalized by only receiving payment based on the formula which determines that shortfall.
Confused? Let’s look at an example.
John insures his $1,000,000 commercial property for $10,000. If his property is totally destroyed, should he expect his insurance to pay for $1,000,000 or $10,000?
It makes little sense to pay 100% of all losses when the amount of insurance purchased is significantly less than the total value of the property.
Sandy owns the unit next to John. Her commercial property is valued at and insured for $1,000,000. If she suffers the same loss as John, should she expect her policy to help pay for John’s loss?
It is unfair to ask other insureds who purchase the required amount of insurance to subsidize those who do not.
The Formula - Coinsurance
Did ÷ Should × Amount of the Loss = Settlement
Example:
150k / 240k (Should in this case is the % required by Co Insurance. Sometimes 80%, 90% of the property) * loss = Settlement
Co-Insurance Deductible - Deductible Clause
When a loss is subject to a co-insurance penalty, the amount of the loss is calculated first, followed by the amount of the deductible. In the example above, the insurer would first calculate the loss of $18,750 and then apply the appropriate deductible. If that deductible was $1,000, the net payment to Antonia would be $17,750.
Risk Analysis
Construction.
- Masonry and fire-resistive buildings that use modern building materials make a risk more attractive than a frame structure.
- The age of the building impacts the viability of its mechanical components and has a direct relation on whether a building meets modern building and fire codes.
2)Occupancy.
- The occupancy of the building by both the insured and others will affect the fire rate.
- In multi-occupancy buildings, the occupant with the highest exposure will affect the rate of all the building occupants.
- The type of contents (either raw or finished products) and the manufacturing process to produce those items directly affects the rate. For example, an insurance broker’s office would generate a rate well below a plastic parts manufacturer with highly flammable stock.
3)Protection.
•The availability and type of fire protection has a direct effect on the rate. Public protection includes the distance from fire hydrants (which determines water supply) and the number of local professional full-time fire stations (which determines response time). Private protection includes the internal activities of the building to prevent or reduce loss (such as sprinkler systems, fire extinguishers, and properly installed and monitored central station fire detection systems). These protections will reduce the rate for a risk.
4)Location.
•The physical location has a direct effect on the rate. The distance from other buildings, the construction of neighbouring buildings, and the character of the neighbourhood all impact the rate.
5)Claims History.
•The insurer will review the claims history of the insured and of similar businesses over a period of time (for example, the previous five years) to determine both the frequency and average severity of losses. Even though a loss is an unforeseen event in the future, the past history of both the insured and the industry is a pretty good indication of the likelihood of loss.
Policy Forms
Named Perils
Broad Form
Named Perils Form (IBC 4036)
The Named Perils Form (IBC 4036) is a very basic form that provides limited coverage for a risk. It can be used for difficult risks or for risks that require only limited coverages.
The Named Perils Form provides coverage for:
- Fire.
- Lightning, including loss or damage to electrical devices.
- Explosion (limited).
- Impact by aircraft, spacecraft, or land vehicles.
- Riot, vandalism, or malicious acts.
- Smoke due to a sudden, unusual, and faulty operation of any stationary furnace.
- Leakage from fire protective equipment.
- Windstorm or hail.
Broad Form (IBC 4037)
The Broad Form (IBC 4037) insures against all risks of physical loss or damage, subject to policy limits and exclusions. It is comparable to a comprehensive policy in habitational insurance.
Note that there is a Broad Form Homeowner Policy which provides all-risks coverage on the building and named perils on the contents. However, in commercial insurance, a Broad Form is entirely all-risks, so the loss is insured unless a specific exclusion in the policy says it is not. When you hear the term “Broad Form,” it’s important to be clear whether it’s a personal or commercial policy.
Even the term “all-risks” is a misnomer. It would be rare to find an insurance policy which insures against all losses without exception. All policies contain exclusions for both property and perils insured, as well as a number of miscellaneous conditions. Insureds need to be reminded that even the broadest coverage forms have limitations in what they insure.
Earlier in this chapter, we learned the definition of property, what it includes, and what needs to be identified on the declarations page. Now, we’ll examine the specific property and perils that are excluded under the Broad Form.
Examples of excluded property include:
- Sewers, drains, and watermains located beyond the outside bearing walls.
- Street clocks and exterior signs.
- Animals, birds, and fish.
- Money, platinum, cash cards, evidence of debt or title.
- Automobiles, watercraft, aircraft (but not unlicensed automobiles or unlicensed trailers) used on the insured premises while on the insured’s business.
- Property in the custody of sales representatives outside the premises, unless an amount is shown on the declarations page for the sales representative.
- Any pressure vessel having a working pressure greater than 103 kilopascals.
- Any boiler, including its connecting pipe and equipment, containing steam or water under steam pressure.
Examples of excluded perils include:
- Earthquake.
- Flood.
- Seepage and leakage.
- Backup or overflow of water from sewers, sumps, septic tanks, and drains.
- The entrance of rain, sleet, or snow through doors, windows, skylights, or other openings.
- Centrifugal force, mechanical, or electrical breakdown.
- Failure to control temperature or humidity.
- Trade losses.
- Pollution and contamination.
Common Clauses
DEBRIS REMOVAL CLAUSE
REINSTATEMENT CLAUSE - Under contract law, the insurer’s financial obligation to the insured is over when the limits of insurance have been fully used to pay claims. However, the unique nature of insurance contracts has resulted in insurers including the reinstatement clause in commercial and other property insurance policies. This clause means that the limits of insurance provided by the policy remain unchanged for the entire policy period, regardless of the number and amounts of claims paid.
SUBROGATION CLAUSE - to not go after those who have an insurable interest in the property
Property Away from the Insured Premises Policy
Commercial property insurance coverages apply only at the location noted on the declarations page. For an additional premium, coverage can be purchased and added to the policy to provide for both property in transit (by both the insured’s and others’ vehicles) and property at a temporary location not owned, rented, or controlled by the insured.
Glass Coverage Policy
Limited coverage is available under the Broad Form for exterior glass. Exterior or interior glass (such as in a mall) requires additional coverage. Many tenants, whether in a mall or street-facing building, have leases that require them to be responsible for loss to the glass of their unit. The combination of glass, ornamentation, lettering, and artwork is a significant investment for the insured.
Many insurers’ glass coverage policies provide as few as three exclusions:
1) Fire.
2) War.
3) Nuclear energy hazard.
Valuable Papers and Records Policy
Valuable papers are defined in IFC 51065 as “written, printed and otherwise inscribed documents and records, including books, maps, films, drawings, abstracts, deeds, mortgages and manuscripts but does not mean money or securities.”
Standard commercial property insurance policy coverages restrict payment for records to their blank value only. But when an insured purchases this coverage, all costs of reproducing lost or damaged documents are covered.
Accounts Receivable Policy
Many insureds extend credit to their customers through their business. If those records are destroyed, this policy can offer coverage. The act that destroyed them (that is, the peril) does need to be listed in this policy for it to respond, but the intent of the coverage is to pay the costs of reconstructing accounts receivable records, abnormal expenses incurred in collecting sums due to the insured, and interest charges on loans needed to offset uncollected amounts.
Office Equipment Floater
Businesses operate in a variety of forms, from retail to manufacturing — but offices are extremely common. Unlike retail or manufacturing environments, these office businesses (such as accountants, lawyers, and insurance brokers) do not contain any stock under the strict definition, but they do contain equipment. This policy provides all-risks coverage on all the office equipment, and generally includes accounts receivable, valuable papers, and extra expense.
Electronic Data Processing Policy
Very few businesses can operate without automation. From inventory control in warehouses to sales checkout in retail stores, all businesses rely on automated systems to some degree. Even operations in insurance brokerages, from application to record storage, are digitized. This means a computer failure can result in a total shutdown of a business operation.
Coverage under the standard commercial property forms is often not sufficient to fully address the unique losses that insureds using automated systems are exposed to. The Broad Form typically excludes losses caused by artificially generated electrical currents (for example, a power surge).
The loss of data is excluded under the Broad Form Policy, so insureds need to purchase coverage for the computer system in their office or business through an electronic data processing policy. There is no standard policy for this purpose, so brokers must be aware that the following coverages need to be on the form for their client:
- Loss to data processing systems, including equipment and component parts.
- Active data processing media, including programs.
- Extra expense.
Clients will need coverage for the hardware, the software, and the expenses to rent systems from others until the covered property is back online. An all-risks policy will provide coverage for water losses, including leakage, seepage, freezing, and flood, as well as mechanical breakdown.
There are exclusions on all policies, so be aware of the limitations on each form.
Crime Insurance Policy
Commercial property insurance typically provides coverage for riots, vandalism, and malicious acts. The Broad Form policy provides coverage for theft of stock and equipment. However, even the broadest policies exclude money, securities, jewellery, furs, and other valuable property when the loss is due to a criminal act. As always, brokers need to be deeply knowledgeable about their insured’s business in case there are exposures requiring additional coverages.
Burglary insurance is required in any business where the stock or equipment has high value or by its nature is very attractive to thieves. Burglary insurance will only pay when there are signs of forced entry to or from the insured property. The insured can purchase either mercantile stock burglary insurance or safe burglary insurance.
Robbery insurance is purchased where there is potential loss to money, securities, and other valuable property. Robbery insurance will pay when there is the threat of force against the person having control of the property (for example, a thief threatening a staff member with harm to turn over cash from the register). Robbery insurance applies to both inside and outside the premises.
Theft is the broadest form of crime, involving property taken without the owner’s consent. An insured who purchases theft coverage does not have to purchase burglary or robbery insurance, but the premium will reflect the extent of this coverage. Theft coverage includes options such as: Broad Form (covering stock and equipment); Money and Securities Broad Form; Employee Theft and Fidelity coverages; and the Comprehensive Dishonesty, Disappearance, and Destruction Policy (also known as the 3-D Policy).
The 3-D Policy provides a comprehensive package of crime insurance coverage under a single policy form. It includes five insuring agreements, and there are 48 approved endorsements to this policy which allow the broker to amend the coverage to a particular risk.
Equipment (Boiler and Machinery) Breakdown Policy
The Commercial Property Broad Form excludes “loss or damage to buildings resulting from explosion of the following whether owned, operated or controlled by the insured: Boilers and pressure vessels operating at more than 15 psi.”
Many large buildings heat with hot water and require large boilers operating at pressure to provide the heat. Many also have large electrical systems, electric motors, compressors and pumps, and air conditioning systems. Brokers will conduct surveys of the building to identify any building systems and equipment that require this specific coverage.
This is specialized insurance, so the insurance company will inspect the objects being insured. The inspection can be done at any time. If the inspector deems the equipment as unfit or dangerous, they can tag the equipment and suspend the coverage immediately, without notice to the mortgagee.
Contractor’s Insurance
Commercial property insurance does not cover buildings during construction. A separate Builders Risk Form is required to provide coverage for this exposure. This policy can be purchased by either the contractor or the future owner of the building.
This policy insures the value of all materials owned by the insured and others entering into and forming part of the completed project. It excludes the contractor’s tools and equipment (which require its own coverage under a contractor’s equipment floater) and the cost of making good faulty workmanship. The policy is meant to cover only the period when the building is under construction; this means it will likely cease before the building becomes occupied. It can also cease if the project has been left in an unaltered state or there has been no construction activity for more than 30 consecutive days.
The limit purchased is based on the completed value.
SPECIFIC POLICY FORMS
Business Interruption Insurance
